Understanding Global Competitiveness

Ukraine’s index of competitiveness has dropped somewhat from last year. Today Ukraine ranks sixtieth, down from 56th place, in a ranking of 75 countries. In terms of economic indicators, Ukraine now leads El Salvador, Zimbabwe, Nicaragua, and Honduras. Ukraine is in the company of such second wave European Union candidates as Romanian and Bulgaria, while it closely trails 58th place Russia. In truth, Ukraine’s lower indicator of competitiveness is no reason for superfluous faultfinding, since only five republics of the former Soviet Union figure in the ranking: the Baltic states, Russia, and Ukraine.

This month the World Economic Forum and the Harvard Center for International Development issued its Global Competitiveness Report for 2001. Finland, the US, and Canada ranked first through third among the 75 countries studied, while Nicaragua, Nigeria, and Zimbabwe ranked in the last three places. (All rankings can be found at www.weforum.com). As co-director of this annual study, I am often asked what competitiveness actually means. Do countries really compete economically, in the way that they do militarily? Does it make sense to say that Finland is more competitive than, say, Germany or Italy?

For the purposes of our report, we define competitiveness in a precise way: as a country’s capacity to achieve sustained economic growth in the medium term — i.e., five-years. In defining competitiveness we are not claiming that one country’s competitiveness means another country’s lack of competitiveness. With better policies all countries in the world could simultaneously achieve higher growth. Even so, it does make sense to rank countries regarding their capacity to achieve growth. Each country is interested in knowing whether its policies and institutions stack up against those of other nations in the capacity to achieve and sustain economic growth.

There are aspects of growth that are like head-to-head competition, in which the gains of one country or region can be at the expense of another country or region. Countries compete for internationally mobile capital. The more one country reaps in foreign direct investment, the less investment another country can attract. This is clear when countries compete for an individual investment project. When Intel plans a new semiconductor plant, it invites bids from various countries. The competition is fierce to attract the project, and usually involves tax breaks, commitments on infrastructure, and even promises about the engineering curriculum in the local university.

In this year’s rankings, we determined a country’s competitiveness (the capacity to grow) according to three broad criteria: (1) technology; (2) public institutions; and (3) macroeconomic stability. Indexes were created in each of these categories and then averaged in a specific manner to create an overall Growth Competitiveness Index.

Technology refers to the ability of the country to spur new inventions and to adopt technologies invented in other countries. Some countries, like the US, Japan, Korea, Israel, and Sweden, invest heavily in research and development, and thus achieve high rates of innovation. Other countries, like Argentina and Brazil, invest less in research and development, and therefore achieve little in the way of new products and processes. Innovators enjoy a high level of prosperity as the result of their innovations. Here the US, Canada, and Finland rank first through third.

Public institutions refer to the quality of governance. Is there widespread corruption? Are courts honest and impartial in their judgments? Can governments be trusted to follow through on their commitments? Countries with well-functioning public institutions achieve higher rates of economic growth than do countries plagued by corruption and rotten judges. High ethical standards promote better economic performance. Northern Europe stands at the top of the world in this regard, with Finland, Iceland, and Denmark ranking first through third. Corruption is deemed nearly non-existent in these countries.

Macroeconomic stability refers to the absence of inflation, budget balance, a realistic value for the exchange rate, the ability of businesses and government to obtain market loans, and high confidence that government financial obligations will be honored. We have learned in the past decade that even when businesses are internationally competitive, a macroeconomic crisis can derail economic growth, as it did in most of Asia in the late 1990s. Singapore, Ireland, and Switzerland are the three top-ranked countries in terms of macroeconomic stability.

In our competitiveness studies, we noticed that the world economy can be divided into two categories of countries: innovators and non-innovators. Only about twenty countries in the world are active creators of new inventions. For these countries, which tend to be among the world’s richest, continued competitiveness requires an excellent system of technological innovation.

Universities must be excellent, government laboratories should be world class, and government and industry should be investing heavily in research and development. A key determinant of future growth among these economies is the proportion of students that go on to higher education after high school. This proportion is now around 80% of students in Canada and the US.

For “non-innovators,” technology remains important, but in these countries most new technologies are imported from abroad rather than invented at home. Some of these countries are good at importing new technologies, and others are not. For the past decade or more, a great deal of technological imports came in the context of foreign direct investment. When American firms invested heavily in Mexico, or Taiwanese firms invested heavily in mainland China, the firms brought with them new technologies that upgraded the production efficiency of the host economy. So it made sense for countries to compete vigorously for such foreign investors: they offer not only capital, but also new technologies.

A strength and weakness of our analysis of competitiveness is that it focuses on the medium term, not the coming year or two. Our rankings cannot be used to assess short run cyclical conditions in an economy, but do provide insights into the longer-term prospects of major economies. Thus, it is ironic that many of this year’s leaders in competitiveness, such as the US and Singapore, are in recession, while countries further down the list, like China (39th), will escape the global recession.

Part of the slowdown relates to the terrorist attacks of September 11, but it is becoming clear that America’s economy, and other economies linked to the US through trade and production networks, were sliding into recession before September. Still, our best guess is that this cyclical downturn will prove temporary, and that in the five-year perspective, the US will continue to demonstrate a strong capacity to achieve economic growth.